Y Combinator: An assembly line for tech start-ups

The Silicon Valley venture capital industry is famously clubby. Its angel investor community, where packs of investors tend to fund start-ups together, is also cliquish.

But underscoring investor appetite for hot Web start-ups, both are reaching out beyond their tight social circles to forge professional and social connections with a new group in town: the growing fraternity of start-ups backed by Y Combinator, a 2-year-old company with offices in Cambridge, Mass., and Mountain View.

The brainchild of entrepreneur Paul Graham - who in 1998 sold his company Viaweb to Yahoo for about $50 million and whose subsequent books and essays have won him a following of programmers - Y Combinator provides seed financing, guidance and killer contacts to entrepreneurs.

That's not so unusual for a fund until you consider that Y Combinator, named after a mathematical construct, doesn't just back promising young companies; it helps create them.

Here's how it works: twice a year, Y Combinator invites "hackers," or programmers, to fill out an online application, outlining who they are and a business idea.One winning batch of teams is funded in winter and the other in summer. With Y Combinator's help, each becomes a real company - one that is expected to create its product within three months. The amount of money Y Combinator gives each group - $5,000, plus an additional $5,000 per founder - is a pittancefor what it asks in return, which is, on average, a 6 percent stake in their start-up.

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That money has to really stretch. Beyond their living and working expenses, it must also cover relocation costs, as the winter winners must relocate to the Bay Area and the summer winners to the Boston area.

"It's no accident that we make people move," said Graham, 42. "It's a test of commitment."

What the start-ups get in return seems to more than make up for the frozen pizza they have to eat. For starters, Y Combinator organizes an "investor day" for each batch of start-ups, where in 10-minute presentations, they pitch their companies to a roomful of 60 to 70 investors.

The start-ups also attend weekly Tuesday night dinners together, where they meet a guest speaker - often an investor looking for a sneak peek at their projects. Those who've spoken include renowned angel investor Ron Conway and venture capitalist Greg McAdoo of Sequoia Capital, which recently co-invested $5 million in Loopt, a mobile application start-up it met through Y Combinator.

"I do worry that another bubble is brewing," Graham said. "The No. 1 question I'm asked (by investors) is: How can I see the companies before everyone else?"

Another, unforeseen, outcome of Y Combinator's mass production process is that its entrepreneurs grow close.

Nowhere is this more apparent than within a sprawling apartment complex in San Francisco's North Beach neighborhood, where more than a dozen Y Combinator entrepreneurs are now living, lured by others in the program who rent there.

There, for example, on the ninth floor in a three-bedroom apartment littered with desktop computers, mounds of cords and stray athletic shoes, live the co-founders of Weebly, a start-up whose software makes it possible for practically anyone to create a snazzy Web site. It received funding from Y Combinator in January, as part of its winter class. (Its summer class, in Cambridge, runs from June through August.)

Chris Fanini, 22, Dave Rusenko, 21, and Dan Veltri, 22 - Pennsylvania State University students who've been taking classes online so they can graduate next month - say they're there because, as Fanini puts it, "these are our friends.

"We bounce ideas off one another. We pass code back and forth and help one another out if anyone in the building has technical issues."

"I moved up here last month from Mountain View," added Robby Walker, the 23-year-old co-founder of Zenter.com - his company, also funded in winter by Y Combinator, is a Web-based replacement for PowerPoint. "It's $1,000 more a month. I'm eating Lean Cuisine every day. But having that connection to the others - I need that."

Maintaining such connections becomes all the more critical when the entrepreneurs become Y Combinator alumni.

Matt Brezina is a Y Combinator alumnus who co-founded the e-mail company Xobni, which recently raised $4.2 million from investors including Khosla Ventures. His take on his fellow entrepreneurs: "These guys will be a great group to know five years from now when I start my next company" and looking to recruit.

That's if those guys aren't busy with their own companies. Weebly raised money from several angels just three days after it presented at investor day. Zenter may have a term sheet by next week. Indeed, of the 13 start-ups most recently funded by Y Combinator, "more than half have solid (follow-on financing) deals," said Graham.

Funding isn't the only action going on at the North Beach building. Writers from the popular blog TechCrunch and junior partners at VC firms spend a lot of time hanging out there, too.

Asked if he was worried that inside information was their primary motivator, Brezina - who recently hitched a ride home from an event in the Lamborghini of Aydin Senkut, an early employee of Google who is now actively investing in Web companies, sometimes with Conway - laughs, "Are they moles? Maybe. But we're all friends with them. We all have similar interests."